Contact Energy is expected to report a strong first half of the financial year with operating profit forecast to be up almost 10 per cent to $252 million, according to a Morningstar report.

Contact is due to report its half year result to the end of December next Tuesday.

The lift in profit would be driven by higher earnings from the company's electricity division, because of lower costs as a result of a fall in wholesale electricity prices and lower generation costs.

The Morningstar report says despite a strong first half, Contact's annual operating earnings would be about $531m, up 5 per cent, as growth moderated in the second half of the year.

Contact's full June 2013 year net profit was forecast to be $184m, up 5 per cent on the previous year, despite an expected lift in electricity profit margins in the half year. Contact Energy shares last traded at $5.18, up from $4.81 a year ago. The shares peaked at $5.54 late last year.

Morningstar rates the Contact shares a "hold" around current levels, with a fair value of $5.50 a share.

Contact is one of the biggest power generators and retailers in New Zealand. About half its generation is thermal, with the balance from hydro power and growing geothermal generation.

Its big new 166 megawatt Te Mihi geothermal station near Taupo is due to be running by the middle of the year.

Contact's unit cost of power generation was expected to fall over time because of lower gas costs and the commissioning of Te Mihi.

Te Mihi is expected to save around $60m to $70m in production costs when it comes on stream and would likely replace more expensive thermal generation sources, Morningstar said.

The $620m station is Contact's biggest project under construction.

Another analyst recently said that Contact's new Ahuroa gas storage facility and the Stratford "peaker" power plant, as well as Te Mihi, would have a positive impact on cashflow, which should allow Contact to increase dividend payments.

Late last year, Contact chief executive Dennis Barnes signalled returns to shareholders were likely to be ramped up once the company's big investment programme ended in the current financial year.

Contact has spent at least $350m a year on capital investment recently but that would drop to $100m from 2014. The policy of paying 80 per cent of underlying earnings would be reviewed in light of the higher cashflow, Barnes said.

Morningstar said being both a generator and a retailer somewhat insulated Contact from the vagaries of the wholesale electricity market. That meant its earnings were less volatile than otherwise might be the case, but its thermal plants put it at a disadvantage under the Emissions Trading Scheme regime.

That concern, along with the Government's desire to promote renewable power sources, encouraged Contact to look at geothermal "in a big way", Morningstar said.

Earlier company announcements showed Contact produced 4759 gigawatt hours of electricity in the first half, down from 4916 gwh in the previous comparable period, because of lower thermal production.

But the firm's net purchase costs, including electricity purchases on the wholesale market and generation costs, fell from $49.4 a megawatt hour to $44.2 a mwh. That pushed electricity profit margins up, driving operating profits up 9.5 per cent to $252.7m, Morningstar said.

Wholesale electricity market prices in general fell in recent months because of high hydro power lake levels in the South Island.

With huge rainfall early in January, national hydro storage is now 110 per cent of average. At about 5.6 cents a unit, wholesale electricity prices are about half the levels they were a year ago.